Deal expected to push up BAT's debt levels to four times Ebitda

People walk past the British American Tobacco offices in London, Britain, Oct. 21, 2016.
Photo:
Reuters

The proposed overhaul of the U.S. tax code hasn’t played a significant role in the $49.4 billion takeover deal between British American Tobacco PLC and Reynolds American Inc., BAT Chief Executive Nicandro Durante said Tuesday in a call with analysts.

The “tax discussion in the U.S. has been limited to generalities,” Mr. Durante said. It was impossible to assess the potential impact of the current U.S. tax-code discussions on BAT’s acquisition of the 57.8% of Reynolds that it doesn’t already own, he said.

The two firms on Tuesday announced they had agreed to a sweetened offer which will see BAT pay about $24.4 billion in cash and $25 billion in BAT American depository receipts for the remaining stake in Reynolds.

The planned U.S. tax-code reform was “not part of the deal,” Mr. Durante said. The key part of a U.S. House Republican corporate tax plan would tax imports and exempt exports, in an effort to encourage companies to locate jobs and production in the U.S. Some companies are considering whether such a move would be a viable option.

“This is the right deal at the right time for both sides of shareholders,” Mr. Durante said. The move to create the world’s largest listed tobacco company by revenue and market value was “both strategically and financially compelling,” he said.

BAT is paying $29.44 in cash and 0.5260 of an ordinary share for each Reynolds share, valuing its U.S. peer at more than $85 billion. The deal comes after BAT said in October that it had made an offer for Reynolds valued at $56.50 a share, or about $47 billion for the stake it didn’t own.

The cash component of the transaction will be financed by a combination of existing cash resources, new bank credit lines and the issuance of new bonds, Finance Director Ben Stevens said during the analyst call.

BAT has set up a $25 billion acquisition facility with a syndicate of banks. It comprises bridge loans worth $15 billion and $5 billion with one- and two-year maturities, respectively, a statement on the company’s website said. BAT plans to refinance both bridge loans with bond issuances “in due course,” according to the statement.

The company has taken on two, $2.5 billion term loans with maturities of three and five years.

The deal will push up BAT’s debt levels to four times earnings before interest, taxes, depreciation and amortization, Mr. Stevens said. BAT will treat Reynolds’s legacy debt as pari-passu, he said. BAT said it had net debt of £14.79 billion ($17.96 billion) at the end of 2015.

The company plans to reduce debt to three times Ebitda by the end of 2019, however. “BAT is committed to maintaining a solid investment grade credit rating and intends to delever,” according to the statement.

BAT should manage to do so quickly, said Steve Clayton, fund manager at Hargreaves Lansdown PLC. “We can’t ignore the debts that BAT are taking on to fund the deal,” Mr. Clayton wrote Tuesday in a note. “But tobacco is a very cash-generative business and we expect the enlarged group to be able to pay the debts down quite quickly.”

Fitch Ratings Inc. in October put BAT on rating watch negative and said a downgrade of its A- rating by up to two notches was likely upon the successful completion of the merger because of BAT’s debt increase. “The rating action reflects the likely material balance-sheet releveraging of BAT,” an analyst note read.

BAT forecasts at least $400 million of annualized cost savings three years after the closure of the deal. “As we get closer to Reynolds, we hope to find more cost savings,” Mr. Stevens said.

Due to the lack of geographic overlap, the companies don’t expect increased regulatory scrutiny for their deal, Mr. Durante said. Nevertheless, they have negotiated a breakup fee of up to $1 billion.

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